The Federal Reserve and the Federal Open Market Committee (FOMC) operate under a dual mandate to conduct monetary policies that foster maximum employment and price stability. Adjusting the federal funds rate is one of the tools used by the central bank to influence short-term interest rates, economic growth, and inflation.

Theoretically, lowering interest rates fuels demand for credit and encourages consumers and businesses to spend and invest. Raising interest rates helps to slow economic activity when inflation is seen as the larger threat.

The financial markets often react — and occasionally overreact — to actions taken by the FOMC. But there is much more going on behind the scenes in the Federal Reserve System than the rate decisions that appear in the headlines.

Central Bank Functions

Congress formed the Federal Reserve in 1913 as a way to “provide the nation with a safer, more flexible, and more stable monetary and financial system.” In addition to conducting monetary policy, the Federal Reserve is responsible for supervising and regulating U.S. bank holding companies (BHCs) and financial institutions, overseeing the nation’s payment systems, and providing certain financial services for the U.S. government, financial institutions, and foreign official institutions.

The Federal Reserve System includes a network of 12 Federal Reserve Banks and 24 branches around the nation. Seven governors are appointed by the president and confirmed by the Senate to serve staggered 14-year terms. The Fed chair and vice-chair (currently Janet Yellen and Stanley Fischer, respectively) serve four-year terms and may be reappointed, subject to term limits.

Members of the Board of Governors monitor domestic and international economic and financial conditions, lead committees that study current issues, meet with government organizations, and may be called to testify before Congress. The seven governors also make up the voting majority of the FOMC, with the other five votes coming from the president of the Federal Reserve Bank of New York and four other Reserve Bank presidents, on a rotating basis.

Focus on Risks

Federal Reserve governor Daniel Tarullo heads the Committee on Bank Supervision. The Fed’s regulatory role has expanded significantly since the 2008–2009 financial crisis and passage of the Dodd-Frank Act. Here are several ways the Fed provides oversight to the financial industry.

Emergency lending. The Federal Reserve has long been authorized to lend funds to banks in times of crisis, and it did so extensively in 2008 and 2009. However, Dodd-Frank eliminated the Fed’s ability to rescue failing firms. Emergency lending is now limited to a broad-based effort to loosen credit markets when conditions might otherwise have a severely negative impact on households, businesses, and the U.S. economy.1

Stress tests. The Fed conducts annual supervisory stress tests of bank holding companies with $50 billion or more in total assets. Tests are based on specific adverse scenarios to help evaluate whether they have enough capital to withstand a market shock. The results also help regulators decide whether to approve or reject the BHC’s capital return plans, which affects how much they can pay out to shareholders with dividends or buybacks.2

Capital controls. The Federal Reserve is phasing in tougher stress tests, with stricter capital requirements for “global systemically important ” bank holding companies with $250 billion in total assets or at least $10 billion in foreign exposure. This “risk-based capital surcharge” currently applies only to the nation’s eight largest BHCs, because regulators believe it could pose a threat to global financial stability if just one of them should fail.3 The anticipated costs of regulatory compliance could pressure some of the largest BHCs to stem risks by reducing their size, reorganizing, or changing their business models.4

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